Defence Offsets: Time for Paradigm Change of Approach

Defence Offsets: Time for Paradigm Change of Approach

Major General Mrinal Suman

Although India entered the complex world of defence offsets only seven years ago, it has travelled a long distance and offsets have become an essential part of all high value defence deals. Although MoD prefers to keep all offset activities concealed from public scrutiny, it is estimated that India has signed offset contracts worth Rs 22,000 crores. However, it is still a mystery if any offset contract has been successfully implemented with anticipated benefits. 

India’s defence offset policy has matured through a process of evolution. Initially announced in 2005, the policy was more of a counter-trade arrangement, designed primarily to promote exports from the public sector. The policy was revised in 2006 to include ‘any private defence industry manufacturing these products or components under an industrial licence granted for such manufacture’. It also allowed Foreign Direct Investment (FDI) in Indian defence industry and defence R&D. Subsequently, the mandatory requirement of an industrial licence for private companies was removed in 2008.

The last revision of the policy was carried out in January 2011 as a part of the defence procurement procedure. The latest policy directive, called Defence Offset Guidelines (DOG), has been made effective from 01 August 2012. The directive contains two major changes –objectives of the defence offset policy have since been spelt out and transfer of technology (ToT) has been accepted as an eligible avenue for discharging offset obligations. 

Salient Aspects of the Policy

As per the Indian policy, all import deals with an indicative value of more than Rs 300 crores carry an offset obligation equal to 30 percent of the contract value. Offset percentage can be changed or waived by the Defence Acquisition Council (DAC). Offset obligations can be discharged within a timeframe that can extend beyond the period of the main contract, but within two years of the main deal being implemented.

Foreign vendors can choose their Indian partners and discharge their offset obligations through any one or a combination of the seven specified methods. They include direct purchase of, or executing export orders for, eligible products manufactured by, or services provided by Indian enterprises; FDI in joint ventures with Indian enterprises (equity investment) for the manufacture and/or maintenance of eligible products and the provision of eligible services; investment in ‘kind’ in terms of ToT to Indian enterprises for the manufacture and/or maintenance of eligible products and provision of eligible services; investment in ‘kind’ in Indian enterprises in terms of provision of equipment through the non-equity route for the manufacture and/or maintenance of eligible products and provision of eligible services; provision of equipment and/or ToT to government entities engaged in the manufacture and/or maintenance of eligible products and provision of eligible services, including the Defence Research and Development Organisation (DRDO); and technology acquisition by DRDO in areas of high technology.

Products eligible for discharge of offsets relate to defence, internal security and civil aerospace. ‘Services’ mean maintenance, overhaul, upgradation, life extension, engineering, design, testing of eligible products and related software or quality assurance services with reference to the indicated eligible products and training. Training may include training services and training equipment but excludes civil infrastructure.

An Appraisal of the Current Dispensation

Although the offset regime continues to be highly obscure, two audit reports submitted by the Comptroller and Auditor General of India (CAG) provide a rare glimpse of its imperfections and absurdities. The first report covers a review of 16 offset contracts worth Rs 18,444.56 crore (Report No 17 of 2012-13). According to the contracts, India should have received offset inflows of Rs 5543.33 crore at the time of compilation of the said report. Actual gains have neither been collated nor revealed. The second report relates to the acquisition of helicopters for VVIPs (Report No 10 of 2013).

Both the reports are alarming in nature, to say the least. They reveal that India’s offset regime is in a total mess. Policy provisions are being flouted with impunity. Unauthorised programmes have been accepted against offset obligations. In some cases, foreign vendors have been allowed to claim credit against outlandish activities like expenditure incurred on the conduct of seminars in India. Offset credits have been granted against the supply of simulators, despite specific instructions to the contrary.

Bizarrely, ineligible Indian companies with more than 26 percent foreign holding have been accepted as Indian Offset Partners, thereby making a mockery of the concept of offsets since most benefits flowed back to the foreign holders. As MoD has no mechanism in place to monitor offset programmes, it is being forced to accept the progress reports submitted by the vendors. In short, the foreign vendors are calling the shots and MoD is helplessly acquiescing.

The success of any offset programme primarily depends on its proper selection, detailed planning, close supervision and regular monitoring. India has failed in all respects. CAG reports reveal that there has been no value addition in India due to the flawed policy and faulty implementation. As offsets do not come for free and carry cost penalty, India has suffered considerable financial outflow without commensurate benefits.

Need to Exercise Caution

As is apparent from the CAG reports, the current offset policy suffers from major infirmities. Guidelines for the transfer of technology are far too complex and lack clarity, thereby lending themselves to multiple interpretations. Procedure for the selection of high technology for receipt by DRDO is too convoluted to succeed. The concept of multipliers has been rendered ineffective and purposeless by making it usage-based rather than linking it with the level of technology on offer.  Finally, instead of having a single authority with decision making powers to oversee all facets of offset activities, India has chosen to have two agencies – the Acquisition Wing and the newly created Defence Offset Management Wing. It is a sure recipe for bureaucratic turf battle.  

It is time India carries out a paradigm shift in its fundamental approach towards offsets. To start with, offsets should not be mandatory for all major deals. It should be based on case-by-case decisions of DAC. Need and desirability of seeking offsets should be debated at length while categorising a procurement proposal. Offsets should be demanded only when the envisaged benefits justify the likely cost-penalty.

Offset programmes must always be in consonance with national priorities and should fill an important technological/economic void. As relevance of offset programmes is of critical importance, the choice cannot be left to the discretion of vendors who will invariably opt for the cheapest and the easiest routes. Therefore, DAC must decide detailed contours and scope of offsets that the vendors should offer. RFP must contain these details upfront.

As recommended by the Transparency International, vendors should be asked to submit two commercial quotes in two separate sealed envelopes duly marked – one with the stipulated offset package and the other without any offset obligations. Such an approach will force vendors to reveal the true offset cost being charged by them, thereby facilitating value-for-money evaluation.

Commercial evaluation of the technically acceptable vendors should be done by opening commercial quotes without offset packages. It implies that offset packages should not influence determination of the lowest bidder. Once the lowest bidder is identified, his offset quote should be opened for a reality check to ascertain whether seeking specified offsets makes economic sense or not. In case it is felt that the indicated cost-penalty does not justify the advantages likely to accrue from the offsets, the requirement of offsets should be dropped.

The Way Forward

The current euphoria about the benefits accruing from offsets is highly misplaced. India will do well to pay heed to the caution sounded by the Transparency International that offsets are very prone to corruption. Indian defence procurement regime is already mired in controversies, contract for the purchase of helicopters for VVIPs being the latest imbroglio. CAG has faulted the contract for non-compliance with the provisions of DPP. Worse, work completed prior to the award of the helicopter contract was allowed against offset obligations.

Offsets are certainly a highly potent tool in the hands of assiduous experts but become an imprudent activity when handled in an amateurish manner. Inappropriately selected, poorly implemented and casually monitored programmes invariably prove to be wasteful. More worrisomely, they hold the ominous potential of getting embroiled in allegations of corrupt practices, thereby derailing planned modernisation of the armed forces. It is a harsh reality that many nations have learnt at a great cost. Therefore, India must revisit the complete policy lest it proves detrimental to national security imperative.*****